Budgeting with Variable Income

One of the biggest struggles I hear from freelancers and entrepreneurs is how to budget with variable income. Some expenses like rent are fixed, yet their monthly business income is not. Sure, you can always sign an additional client, but there are only so many working hours in the day. And slow months happen, whether intentionally or unintentionally. On top of that, business owners are dealing with two budgets: their personal and business budgets.

Before you start thinking about income goals and pricing, it’s important to determine the bare bones budgets for your personal finances and business. Or as Kim Vargo of Yellow Brick Home calls it, your “spaghetti number.” On the personal side, these are your nonnegotiable expenses: rent/mortgage, utilities, insurance, groceries, etc. On the business side, this might include website hosting and registration fees, service fees when invoicing a client, computer software, or legal and professional fees. We’ll add savings, retirement, and taxes later.

If you’re not sure about your spending, I recommend creating an account with mint.com. Mint is a free and secure online money management and budgeting tool. You can even create separate personal and business accounts using two different email addresses. Simply link up your checking, savings, credit card, retirement, and debt accounts to see your financial picture all in one place.

Once you’ve calculated your minimum personal and business expenses, you have your bare minimum income goal for each month. From here, it’s time to layer on savings, retirement, and taxes.

While there are as many spending/savings plans as there are diets, the “50/20/30 Plan” keeps things fairly simple: 50% Needs, 20% Savings, and 30% Wants. Your bare bones personal and business budgets are the 50% Needs. The 20% includes saving, retirement, and investing goals. The last 30% for Wants includes hobbies, eating out, and other lifestyle choices. If you have debt payments, include those in the “Savings” bucket.

But what about taxes?

Saving for Taxes

If you’re an entrepreneur, your income is mostly likely pre-tax dollars. That means when tax time rolls around, you are responsible for your personal income taxes and self-employment taxes (Social Security and Medicare taxes). Therefore, it’s extremely important to set aside your tax dollars with each paycheck.

Depending on your personal situation (whether you’re married or single) and which state you live in, you’ll pay somewhere between 20% to 30% of your total income in taxes. Here’s how it breaks down:

Social Security tax – 12.4%

Medicare tax – 2.9%

Marginal tax rate – 10%

Note: The marginal tax rate usually starts at 10% and increases as taxable income increases.

BASE TOTAL = 25.3%

Therefore, I recommend saving at least 20% for taxes. Save 25 to 30% of your pre-tax business income to be safe.

As for where to save your money, I recommend opening a separate bank account just for your taxes. FDIC-insured online banks like CapitalOne 360 or Ally Bank have no minimums or fees. Additionally, they offer a higher yield than traditional savings accounts.

As a business owner, you are also responsible for paying quarterly estimated taxes. If you don’t, you’ll be responsible for a failure to pay penalty (and likely interest and fees) when you file your tax return. You can estimate your quarterly taxes using an accounting program like QuickBooks Self-Employed, this online self-employment tax calculator, or by working with your accountant, like me!.

You’ll need to know your gross income and total business expenses for each month. Take your gross monthly income, less your total business expenses, and multiply this figure (your net business income) by 20% to 30% or whatever you think is the closest to your tax rate.

Since every financial situation is different, consult with and create a personalized tax plan with your accountant, like me!